The black swan risk now is a US recession

The black swan risk now is a US recession, per Bloomberg.

Last year, when many expected the US economy to fall into a recession due to the Fed’s rapid tightening, it was dubbed the most anticipated recession ever.

Today, the narrative has shifted. The expectation is for a no-landing US economy that continues to advance, boosting stocks and other risk assets. However, there are doubts. Recent data suggests that just as we’re reaching a Goldilocks consensus, the US economy is starting to show signs of weakness. In the worst-case scenario, this weakness could turn into a recession. Since this outcome is not anticipated, it would be a very nasty surprise for investors.

The no-landing scenario may hold in the short term, but it is unlikely to persist for the foreseeable future. Here’s the reasoning behind why a recession is a tail risk worth considering.

Tail risks have materialized over the past year. When investors were asked two weeks ago, “What do you see as the top tail risk between now and the end of the year?”, 59% of respondents cited a resurgence in inflation. This is more than twice the 23% who saw a recession as a top tail risk. Consider this in the context of recent events: After the most aggressive global tightening cycle in four decades, metrics like the NY Fed’s yield curve recession predictor were issuing the loudest recession warnings since the early 1980s. Yet, the economy continued to move forward.

In fact, growth in the US economy actually accelerated, challenging economic orthodoxy and prompting macro analysts to raise their S&P 500 price targets. This was especially true after the so-called Fed pivot, when Fed Chair Jerome Powell did not push back against the market’s aggressive easing predictions during the December 2023 post-meeting press conference. After that, the tail risk was that an accelerating economy would keep delaying those expected rate cuts, which was welcomed by stock-market investors who saw it as a sign to invest in risk assets.

Looking ahead, when considering tail risks, we’re thinking of outcomes that are not the base-case market views—those that would catch most people by surprise but still have a reasonable possibility of happening. Resurgent inflation as a tail risk? If 59% of respondents believe it’s something to watch out for, how is it a tail risk? And even if it is one, it’s likely already partially priced in, given those responses.